10-Q 1 tin10q12003.txt 10-Q FOR THE QUARTER ENDED MARCH 29, 2003 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended March 29, 2003 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition Period From to Commission File Number 001-08634 Temple-Inland Inc. (Exact name of registrant as specified in its charter) Delaware 75-1903917 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 1300 South MoPac Expressway, Austin, Texas 78746 (Address of principal executive offices, including Zip Code) (512) 434-5800 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Number of common shares outstanding Class as of March 29, 2003 Common Stock (par value $1.00 per share) 54,042,894 Page 1 of 47 The Exhibit Index is page 45. 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SUMMARIZED STATEMENTS OF INCOME PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited
First Quarter 2003 2002 ------ ------ (in millions) NET REVENUES $ 847 $ 747 COSTS AND EXPENSES Cost of sales 796 657 Selling and administrative 75 68 Other (income) expense 9 -- ------ ------ 880 725 ------ ------ (33) 22 FINANCIAL SERVICES EARNINGS 39 27 ------ ------ OPERATING INCOME 6 49 Interest expense (35) (25) ------ ------ INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE TAXES (29) 24 Income tax (expense) benefit 12 (9) ------ ------ INCOME (LOSS) FROM CONTINUING OPERATIONS (17) 15 Discontinued operations -- -- ------ ------ INCOME (LOSS) BEFORE ACCOUNTING CHANGE (17) 15 Effect of accounting change (1) (11) ------ ------ NET INCOME (LOSS) $ (18) $ 4 ====== ======
See the notes to consolidated financial statements. 3 SUMMARIZED BALANCE SHEETS PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited
First Quarter Year-End 2003 2002 ------ ------ (in millions) ASSETS Current Assets Cash $ 9 $ 17 Receivables, net of allowances of $13 in 2003 and $13 in 2002 382 352 Inventories: Work in process and finished goods 86 69 Raw materials and supplies 232 269 ------ ------ Total inventories 318 338 ------ ------ Prepaid expenses and other 64 50 ------ ------ Total current assets 773 757 ------ ------ Investment in Financial Services 1,171 1,178 Property and Equipment: Land and buildings 639 638 Machinery and equipment 3,430 3,412 Construction in progress 85 92 Less allowances for depreciation (2,150) (2,101) ------ ------ 2,004 2,041 Timber and timberlands - less depletion 504 508 ------ ------ Total property and equipment 2,508 2,549 Goodwill 243 249 Assets of Discontinued Operations 29 78 Other Assets 146 146 ------ ------ TOTAL ASSETS $ 4,870 $ 4,957 ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Accounts payable $ 195 $ 188 Employee compensation and benefits 50 67 Accrued interest 26 30 Accrued property taxes 16 28 Other accrued expenses 127 133 Liabilities of discontinued operations 21 28 Current portion of long-term debt 7 8 ------ ------ Total current liabilities 442 482 Long-Term Debt 1,879 1,883 Deferred Income Taxes 220 245 Postretirement Benefits 148 147 Pension Liability 152 142 Other Long-Term Liabilities 105 109 ------ ------ Total Liabilities 2,946 3,008 Shareholders' Equity 1,924 1,949 ------ ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,870 $ 4,957 ====== ======
See the notes to consolidated financial statements. 4 SUMMARIZED STATEMENTS OF CASH FLOW PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited
First Quarter 2003 2002 ------ ------ (in millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income (loss) $ (18) $ 4 Adjustments: Depreciation, depletion and amortization 58 49 Depreciation of leased property 1 1 Non-cash stock based compensation 9 2 Non-cash pension and postretirement expense 14 6 Cash contribution to pension and postretirement plans (3) (3) Impairment of long-lived assets 4 -- Deferred income taxes (13) 6 Unremitted earnings from Financial Services (25) (24) Dividends from Financial Services 35 50 Working capital changes, net (47) (41) Net assets of discontinued operations (5) (3) Cumulative effect of accounting change 1 11 Other 9 (3) ----- ----- 20 55 ----- ----- CASH PROVIDED BY (USED FOR) INVESTING Capital expenditures (29) (26) Sales of non-strategic assets and operations 30 -- Acquisition of Gaylord, net of cash acquired -- (525) Other acquisitions and joint ventures (3) (10) ----- ----- (2) (561) ----- ----- CASH PROVIDED BY (USED FOR) FINANCING Bridge financing facility -- 847 Payment of assumed Gaylord bank debt -- (285) Other additions to debt 1 39 Other payments of debt (6) (57) Cash dividends paid to shareholders (19) (16) Other -- 3 ----- ----- (24) 531 ----- ----- Effect of exchange rate changes on cash (2) -- ----- ----- Net increase (decrease) in cash (8) 25 Cash at beginning of period 17 3 ----- ----- Cash at end of period $ 9 $ 28 ===== =====
See the notes to consolidated financial statements. 5 SUMMARIZED STATEMENTS OF INCOME FINANCIAL SERVICES Unaudited
First Quarter 2003 2002 ------ ------ (in millions) INTEREST INCOME Loans and loans held for sale $ 133 $ 146 Securities available-for-sale 20 31 Securities held-to-maturity 39 10 Other earning assets 1 1 ------ ------ Total interest income 193 188 INTEREST EXPENSE Deposits 53 65 Borrowed funds 45 31 ------ ------ Total interest expense 98 96 ------ ------ NET INTEREST INCOME 95 92 Provision for loan losses (11) (14) ------ ------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 84 78 ------ ------ NONINTEREST INCOME Loan servicing fees 9 11 Amortization and impairment of servicing rights (18) (8) Loan origination 43 30 Gain on sale of loans 23 13 Real estate operations 8 9 Insurance commissions and fees 10 11 Service charges on deposits 8 7 Operating lease income 2 3 Other 10 9 ------ ------ Total noninterest income 95 85 ------ ------ NONINTEREST EXPENSE Compensation and benefits 83 76 Loan servicing and origination 3 1 Real estate operations, other than compensation 7 7 Insurance operations, other than compensation 3 4 Occupancy 8 9 Data processing 7 10 Other 29 29 ------ ------ Total noninterest expense 140 136 ------ ------ INCOME BEFORE TAXES 39 27 Income tax (expense) (14) (3) ------ ------ NET INCOME $ 25 $ 24 ====== ======
See the notes to consolidated financial statements. 6 SUMMARIZED BALANCE SHEETS FINANCIAL SERVICES Unaudited
First Quarter Year-End 2003 2002 ------ ------ (in millions) ASSETS Cash and cash equivalents $ 327 $ 438 Loans held for sale 920 1,088 Loans receivable, net of allowance for losses of $122 in 2003 and $132 in 2002 9,846 9,668 Securities available-for-sale 1,776 1,926 Securities held-to-maturity 4,192 3,915 Mortgage servicing rights 93 105 Real estate 254 249 Premises and equipment, net 157 157 Accounts, notes and accrued interest receivable 148 159 Goodwill 149 148 Other assets 207 163 ------ ------ TOTAL ASSETS $ 18,069 $ 18,016 ====== ====== LIABILITIES AND SHAREHOLDER'S EQUITY Deposits $ 9,330 $ 9,203 Federal Home Loan Bank advances 3,114 3,386 Repurchase agreements 2,953 2,907 Other borrowings 190 181 Preferred stock issued by subsidiaries 305 305 Obligations to settle trade date securities 470 369 Other liabilities 536 487 ------ ------ TOTAL LIABILITIES 16,898 16,838 ------ ------ SHAREHOLDER'S EQUITY 1,171 1,178 ------ ------ TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 18,069 $ 18,016 ====== ======
See the notes to consolidated financial statements. 7 SUMMARIZED STATEMENTS OF CASH FLOWS FINANCIAL SERVICES Unaudited
First Quarter 2003 2002 ------ ------ (in millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income $ 25 $ 24 Adjustments: Amortization, accretion and depreciation 26 16 Provision for loan losses 11 14 Originations of loans held for sale (3,194) (1,825) Sales of loans held for sale 3,362 2,022 Collections on loans serviced for others, net (24) (99) Originated mortgage servicing rights (6) (21) Other 60 41 ------ ------ 260 172 ------ ------ CASH PROVIDED BY (USED FOR) INVESTING Purchases of securities available-for-sale (4) (13) Principal payments and maturities of securities available-for-sale 161 219 Purchases of securities held-to-maturity (553) (313) Principal payments and maturities of securities held-to-maturity 371 15 Loans originated or acquired, net of collections (239) (5) Sale of mortgage servicing rights -- 19 Sale of loans 11 -- Acquisitions, net of cash acquired (1) (6) Capital expenditures (5) (2) Other (12) (2) ------ ------ (271) (88) ------ ------ CASH PROVIDED BY (USED FOR) FINANCING Net increase (decrease) in deposits 150 (277) Securities sold under repurchase agreements and short-term borrowings, net 2 (182) Additions to debt and long-term FHLB advances 10 319 Payments of debt and long-term FHLB advances (228) (39) Dividends paid to parent company (35) (50) Other 1 (2) ------ ------ (100) (231) ------ ------ Net increase (decrease) in cash and cash equivalents (111) (147) Cash and cash equivalents at beginning of period 438 587 ------ ------ Cash and cash equivalents at end of period $ 327 $ 440 ====== ======
See the notes to consolidated financial statements. 8 CONSOLIDATED STATEMENTS OF INCOME TEMPLE-INLAND INC. AND SUBSIDIARIES Unaudited
First Quarter 2003 2002 ------ ------ (in millions, except per share amounts) REVENUES Manufacturing $ 847 $ 747 Financial Services 288 273 ------ ------ 1,135 1,020 ------ ------ COSTS AND EXPENSES Manufacturing 880 725 Financial Services 249 246 ------ ------ 1,129 971 ------ ------ OPERATING INCOME 6 49 Parent company interest (35) (25) ------ ------ INCOME (LOSS) BEFORE TAXES (29) 24 Income tax (expense) benefit 12 (9) ------ ------ INCOME (LOSS) FROM CONTINUING OPERATIONS (17) 15 Discontinued operations -- -- ------ ------ INCOME (LOSS) BEFORE ACCOUNTING CHANGE (17) 15 Effect of accounting change (1) (11) ------ ------ NET INCOME (LOSS) $ (18) $ 4 ====== ====== EARNINGS (LOSS) PER SHARE Basic: Income (loss) from continuing operations $ (0.31) $ 0.30 Discontinued operations -- -- Effect of accounting change (0.01) (0.22) ------ ------ Net income (loss) $ (0.32) $ 0.08 ====== ====== Diluted: Income (loss) from continuing operations $ (0.31) $ 0.30 Discontinued operations -- -- Effect of accounting change (0.01) (0.22) ------ ------ Net income (loss) $ (0.32) $ 0.08 ====== ====== DIVIDENDS PAID PER SHARE OF COMMON STOCK $ 0.34 $ 0.32 ====== ======
See the notes to consolidated financial statements. 9 CONSOLIDATING BALANCE SHEETS TEMPLE-INLAND INC. AND SUBSIDIARIES First Quarter 2003 Unaudited
Parent Financial Company Services Consolidated (in millions) ASSETS Cash and cash equivalents $ 9 $ 327 $ 336 Loans held for sale -- 920 920 Loans and leases receivable, net -- 9,846 9,846 Securities available-for-sale -- 1,776 1,776 Securities held-to-maturity -- 4,192 4,192 Trade receivables, net 382 -- 382 Inventories 318 -- 318 Property and equipment, net 2,508 157 2,665 Goodwill 243 149 392 Other assets 239 702 891 Investment in Financial Services 1,171 -- -- ------ ------ ------ TOTAL ASSETS $ 4,870 $ 18,069 $ 21,718 ====== ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits $ -- $ 9,330 $ 9,330 Federal Home Loan Bank advances -- 3,114 3,114 Securities sold under repurchase agreements -- 2,953 2,953 Obligations to settle trade date securities -- 470 470 Other liabilities 547 536 1,041 Long-term debt 1,879 190 2,069 Deferred income taxes 220 -- 212 Postretirement benefits 148 -- 148 Pension liability 152 -- 152 Preferred stock issued by subsidiaries -- 305 305 ------ ------ ------ TOTAL LIABILITIES $ 2,946 $ 16,898 $ 19,794 ------ ------ ------ SHAREHOLDERS' EQUITY Preferred stock - par value $1 per share: authorized 25,000,000 shares; none issued -- Common stock - par value $1 per share: authorized 200,000,000 shares; issued 61,389,552 shares including shares held in the treasury 61 Additional paid-in capital 367 Accumulated other comprehensive income (loss) (135) Retained earnings 1,964 ------ 2,257 Cost of shares held in the treasury: 7,346,658 shares (333) ------ TOTAL SHAREHOLDERS' EQUITY 1,924 ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,718 ======
See the notes to consolidated financial statements. 10 CONSOLIDATING BALANCE SHEETS TEMPLE-INLAND INC. AND SUBSIDIARIES Year-End 2002 Unaudited
Parent Financial Company Services Consolidated (in millions) ASSETS Cash and cash equivalents $ 17 $ 438 $ 455 Loans held for sale -- 1,088 1,088 Loans and leases receivable, net -- 9,668 9,668 Securities available-for-sale -- 1,926 1,926 Securities held-to-maturity -- 3,915 3,915 Trade receivables 352 -- 352 Inventories 338 -- 338 Property and equipment, net 2,549 157 2,706 Goodwill 249 148 397 Other assets 676 915 Investment in Financial Services 1,178 -- -- ------ ------ ------ TOTAL ASSETS $ 4,957 $ 18,016 $ 21,760 ====== ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits $ -- $ 9,203 $ 9,203 Federal Home Loan Bank advances -- 3,386 3,386 Securities sold under repurchase agreements -- 2,907 2,907 Obligations to settle trade date securities -- 369 369 Other liabilities 591 487 1,052 Long-term debt 1,883 181 2,064 Deferred income taxes 245 -- 236 Postretirement benefits 147 -- 147 Pension liability 142 -- 142 Preferred stock issued by subsidiaries -- 305 305 ------ ------ ------ TOTAL LIABILITIES $ 3,008 $ 16,838 $ 19,811 ------ ------ ------ SHAREHOLDERS' EQUITY Preferred stock - par value $1 per share: authorized 25,000,000 shares; none issued -- Common stock - par value $1 per share: authorized 200,000,000 shares; issued 61,389,552 shares including shares held in the treasury 61 Additional paid-in capital 368 Accumulated other comprehensive income (loss) (136) Retained earnings 2,000 ------ 2,293 Cost of shares held in the treasury: 7,583,293 shares (344) ------ TOTAL SHAREHOLDERS' EQUITY 1,949 ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,760 ======
See the notes to consolidated financial statements. 11 CONSOLIDATED STATEMENT OF CASH FLOWS TEMPLE-INLAND INC. AND SUBSIDIARIES Unaudited
First Quarter 2003 2002 ------ ------ (in millions) CASH PROVIDED (USED FOR) OPERATIONS Net income (loss) $ (18) $ 4 Adjustments: Depreciation, depletion and amortization 64 56 Depreciation on leased property 2 4 Provision for loan losses 11 14 Impairment of long-lived assets 4 -- Deferred taxes (13) 6 Amortization and accretion of financial instruments 18 6 Originations of loans held for sale (3,194) (1,825) Sales of loans held for sale 3,362 2,022 Working capital changes, net (47) (41) Collections and remittances on loans serviced for others, net (24) (99) Originated mortgage servicing rights (6) (21) Net assets of discontinued operations (5) (3) Cumulative effect of accounting change 1 11 Other 90 43 ----- ----- 245 177 ----- ----- CASH PROVIDED BY (USED FOR) INVESTING Capital expenditures (34) (28) Sale of non-strategic assets and operations 40 -- Purchases of securities available-for-sale (4) (13) Principal payments and maturities of securities available-for-sale 161 219 Purchases of securities held-to-maturity (553) (313) Principal payments and maturities of securities held-to-maturity 371 15 Sale of mortgage servicing rights -- 19 Loans originated or acquired, net of principal collected (239) (5) Proceeds from sale of loans 11 -- Acquisitions, net of cash acquired (4) (541) Other (22) (2) ----- ----- (273) (649) ----- ----- CASH PROVIDED BY (USED FOR) FINANCING Net increase (decrease) in deposits 150 (277) Bridge financing facility -- 847 Payment of assumed Gaylord bank debt -- (285) Additions to debt 11 358 Payments of debt (234) (96) Repurchase agreements and short-term borrowings, net 2 (182) Cash dividends paid to shareholders (19) (16) Other 1 1 ----- ----- (89) 350 ----- ----- Effect of exchange rate changes on cash (2) -- ----- ----- Net increase (decrease) in cash and cash equivalents (119) (122) Cash and cash equivalents at beginning of period 455 590 ----- ----- Cash and cash equivalents at end of period $ 336 $ 468 ===== =====
See the notes to consolidated financial statements. 12 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE A - BASIS OF PRESENTATION The accompanying unaudited interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Therefore, these statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal accruals) considered necessary for a fair presentation have been included. Interim operating results are not necessarily indicative of the results that may be expected for the entire year. For further information, refer to the financial statements and footnotes included in the Annual Report on Form 10-K of Temple-Inland Inc. (the "Company") for the fiscal year ended December 28, 2002. The consolidated financial statements include the accounts of the Company and its manufacturing and financial services subsidiaries. The consolidated net assets invested in financial services activities are subject, in varying degrees, to regulatory rules and restrictions including restrictions on the payment of dividends to the Company. Accordingly, included as an integral part of the consolidated financial statements are separate summarized financial statements for the Company's manufacturing and financial services subsidiaries. The Parent Company (Temple-Inland Inc.) summarized financial statements include the accounts of the Company and its manufacturing subsidiaries (the parent company). The net assets invested in Financial Services are reflected in the summarized financial statements on the equity basis. Related earnings, however, are presented before tax to be consistent with the consolidated financial statements. These financial statements should be read in conjunction with the Company's consolidated financial statements and the Financial Services summarized financial statements. All material intercompany amounts and transactions have been eliminated. Certain amounts have been reclassified to conform to current year's classifications. 13 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE B - EARNINGS PER SHARE Denominators used in computing per share amounts follow: First Quarter 2003 2002 ----- ------ (in millions) Denominators for earnings (loss) per share Weighted average shares outstanding - basic 54.0 49.4 Dilutive effect of equity purchase contracts -- -- Dilutive effect of stock options -- 0.1 ----- ----- Weighted average shares outstanding - diluted 54.0 49.5 ===== ===== As a result of the net loss in first quarter 2003, incremental shares attributable to the assumed exercise of outstanding employee stock options and equity purchase contracts are antidilutive and, therefore, excluded from the computation of diluted earnings per share. Had these shares been included in the computation for first quarter 2003, the effect would not have been material. NOTE C - COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) consists of: First Quarter 2003 2002 ------ ------ (in millions) Net income (loss) $ (18) $ 4 Other comprehensive income (loss), net of taxes: Unrealized gains (losses) on: Available-for-sale securities 4 -- Derivative instruments -- 1 Foreign currency translation adjustments (3) 1 ----- ----- Other comprehensive income (loss) 1 2 ----- ----- Comprehensive income (loss) $ (17) $ 6 ===== ===== At first quarter-end 2003, the aggregate fair value of all derivative instruments was a $9 million liability, consisting of a $9 million liability for an interest rate swap derivative and a $0.1 million liability related to linerboard and OCC derivatives. There was no ineffective portion of derivatives charged to earnings in first quarter 2003 and amounts reclassified from other comprehensive income into earnings were not material. 14 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE D - SEGMENT INFORMATION The Company has three reportable segments: Corrugated Packaging, Building Products, and Financial Services.
----------------------------------------------------------------------------------- For first quarter or Corrugated Building Financial Corporate at quarter-end 2003 Packaging Products Services and Other Total -------------------- ---------- -------- --------- --------- ------- (in millions) Revenues from external customers $ 667 180 288 -- $ 1,135 Depreciation, depletion and amortization $ 41 16 7 2 $ 66 Operating income $ (4) (9) 39 (20)(a) $ 6 Financial Services, net interest income $ -- -- 95 -- $ 95 Total assets $ 2,444 1,126 18,069 79 $ 21,718 Capital expenditures $ 20 8 5 1 $ 34 Goodwill $ 243 -- 149 -- $ 392 ----------------------------------------------------------------------------------- For first quarter or at quarter-end 2002 (in millions) Revenues from external customers $ 557 190 273 -- $ 1,020 Depreciation, depletion and amortization $ 35 14 10 1 $ 60 Operating income $ 22 10 34 (17)(b) $ 49 Financial Services, net interest income $ -- -- 92 -- $ 92 Total assets $ 2,688 1,203 15,711 75 $ 19,677 Capital expenditures $ 17 9 2 -- $ 28 Goodwill $ 314 -- 130 -- $ 444 ----------------------------------------------------------------------------------- (a) Includes a charge of $6 million related to box plant closures, which applies to Corrugated Packaging, and a charge of $3 million related to consolidation and supply chain cost reduction initiatives, which applies to Corporate and Other. (b) Includes a charge of $7 million related to severance and write-off of technology investments, all of which applies to Financial Services.
NOTE E - CONTINGENCIES There are pending against the Company and its subsidiaries lawsuits, claims and environmental matters arising in the regular course of business. The resolution of these matters is not expected to have a material adverse effect on the Company's operations or financial position. NOTE F - ACQUISITIONS The Company acquired effective control of Gaylord Container Corporation on February 28, 2002. The results of Gaylord's operations have been included in the Company's income statement since the beginning of March 2002. During first quarter 2003, the Company completed the allocation of the purchase price to the acquired assets and liabilities of Gaylord, which resulted in a $6 million reduction of goodwill. At first quarter-end 2003, goodwill related to the Gaylord acquisition was $195 million. The allocation is based, in 15 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) part, on estimated amounts for income taxes and other liabilities. Differences between the estimated amount for income taxes and the actual amount will result in an adjustment of goodwill. Additionally, liabilities included in the allocation that are settled for amounts less than estimated, will result in a reduction to goodwill while liabilities settled for more than estimated will result in a charge to income. The following parent company unaudited pro forma information for first quarter 2002, assumes the acquisition of Gaylord and the related financing transactions occurred at the beginning of 2002: Net revenues $ 887 Income from continuing operations 7 Per diluted share Income from continuing operations $ 0.15 NOTE G - DISCONTINUED OPERATIONS At first quarter-end 2003, discontinued operations consist of Gaylord's chemical business and accruals related to the 1999 sale of the bleached paperboard operations. At first quarter-end 2003, the assets and liabilities of discontinued operations includes $12 million of working capital, $16 million of property and equipment, and $20 million of environmental and other long- term accruals. Revenues from discontinued operations for first quarter 2003 were $9 million. NOTE H - OTHER OPERATING (INCOME) EXPENSE Other operating (income) expense consists of: First Quarter 2003 2002 ------ ------ (in millions) Expenses associated with consolidation and supply chain initiatives $ 3 $ -- Loss on closure of box plants 6 -- ----- ----- Total $ 9 $ -- ===== ===== During first quarter 2003, the Company incurred $3 million in expenses related to initiatives to consolidate administrative functions and effect improvements in supply chain management. These expenses consist principally of fees paid to third party consultants. During first quarter 2003, the Company announced its intentions to permanently close two box plants, which resulted in an impairment loss of $4 million related to long-lived assets and $2 million in involuntary employee termination liabilities 16 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) affecting approximately 200 employees. It is expected that the two box plants will close and severance will be paid during second quarter 2003. A summary of the activity related to all facility closure accruals for first quarter 2003 follows:
Beginning Cash End of of Period Additions Payments Period --------- --------- -------- ------ Involuntary employee terminations $ 1 $ 2 $ (1) $ 2 Contract termination penalties 6 -- -- 6 Environmental compliance 13 -- -- 13 Demolition 13 -- (1) 12 ----- ----- ----- ----- Total $ 33 $ 2 $ (2) $ 33 ===== ===== ===== =====
NOTE I - NEW ACCOUNTING PRONOUNCEMENTS Stock-Based Compensation Beginning January 2003, the Company voluntarily adopted the prospective transition method of accounting for stock-based compensation contained in Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based Compensation- Transition and Disclosure, an amendment of FASB Statement No. 123. The principal effect of adopting the prospective transition method is that the fair value of stock options granted in 2003 and thereafter are charged to expense over the option vesting period. As a result of the adoption of this prospective transition method, first quarter 2003 net loss was increased by $0.1 million with no effect on earnings per share. Prior to 2003, the Company used the intrinsic value method in accounting for its stock-based compensation. As a result, no stock-based compensation expense related to stock options is reflected in prior years' net income, as all stock options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Therefore, the cost related to stock-based compensation recognized in net income (loss) for first quarter 2003 and 2002 is less than would have been recognized if the fair value method had been applied to all stock options granted since 1995. The following table illustrates the effect on net income (loss) and earnings (loss) per share as if the fair value method had been applied to all stock options granted since 1995. 17 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) First Quarter 2003 2002 ------ ------ (in millions) Net income (loss), as reported $ (18) $ 4 Add: Stock-based compensation expense, net of related tax effects, included in the determination of reported net income 5 1 Deduct: Total stock-based compensation expense, net of related tax effects, determined under the fair value based method for all awards (7) (3) ---- ---- Pro forma net income (loss) $ (20) $ 2 ==== ==== Earnings (loss) per share: Basic, as reported $ (0.32) $ 0.08 Basic, pro forma $ (0.37) $ 0.04 Diluted, as reported $ (0.32) $ 0.08 Diluted, pro forma $ (0.37) $ 0.04 Asset Retirement Obligations Beginning January 2003, the Company was required to adopt SFAS No. 143, Accounting for Asset Retirement Obligations. The Statement requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time that the obligations are incurred. Upon initial recognition of a liability, that cost is capitalized as part of the related long-lived asset and allocated to expense over the useful life of the asset. The effect of adopting this statement was to increase property, plant and equipment by $3 million, recognize an asset retirement obligation liability of $4 million, and to increase first quarter net loss by $1 million or $0.01 per share for the cumulative effect of adoption. Disposal Activities Beginning January 2003, the Company was required to adopt SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Under this statement, liabilities for costs associated with exit or disposal activities, including restructurings, are recognized when the liability is incurred and can be measured at estimated fair value. The effect on earnings or financial position of adopting this statement was not material. 18 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Other Pronouncements Also during first quarter 2003, the Company was required to adopt FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others and FASB Interpretation No. 46, Consolidation of Variable Interest Entities. The effect on earnings or financial position of adopting these other pronouncements was not material. 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. The actual results achieved by the Company may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include general economic, market, or business conditions; the opportunities or lack thereof that may or may not be presented to and pursued; availability and price of raw materials used; competitive actions by other companies; changes in laws or regulations; the accuracy of certain judgments and estimates concerning the integration of acquired operations; the accuracy of certain judgments and estimates concerning the consolidation and supply chain initiatives; and other factors, many of which are beyond the control of the Company. Results of Operations for the fiscal quarters ended March 2003 and 2002 Summary Consolidated revenues were $1.1 billion in first quarter 2003 compared with $1.0 billion in first quarter 2002. Income from continuing operations was a $17 million loss in first quarter 2003 compared with income of $15 million in first quarter 2002. Income from continuing operations per share was a $0.31 loss in first quarter 2003 compared with income of $0.30 in first quarter 2002. Business Segments The Company manages its operations through three business segments, Corrugated Packaging, Building Products, and Financial Services. Each of these business segments is affected by the factors of supply and demand and changes in domestic and global economic conditions. These conditions include changes in interest rates, new housing starts, home repair and remodeling activities, and the strength of the U.S. dollar, some or all of which may have varying degrees of impact on the business segments. As used herein the term "parent company" refers to the financial statements of the Company and its manufacturing business segments, Corrugated Packaging and Building Products, with Financial Services reflected on the equity method. 20 A summary of the results of operations by business segment follows:
First Quarter 2003 2002 ------ ------ (in millions) Revenues Corrugated Packaging $ 667 $ 557 Building Products 180 190 Financial Services 288 273 ------ ------ Total revenues $ 1,135 $ 1,020 ====== ====== Segment Operating Income Corrugated Packaging $ (4) $ 22 Building Products (9) 10 Financial Services 39 34 ------ ------ Total segment operating income 26 66 ------ ------ Corporate expenses (11) (10) Other income (expense)(a) (9) (7) Parent company interest (35) (25) ------ ------ Income (loss) before taxes (29) 24 Income tax (expense) benefit 12 (9) ------ ------ Income (loss) from continuing operations (17) 15 Discontinued operations -- -- Effect of accounting change (1) (11) ------ ------ Net income (loss) $ (18) $ 4 ====== ====== (a) Other income (expense) includes (i) in 2003 a $6 million charge for box plant closures, all of which applies to Corrugated Packaging, and $3 million of expenses for consolidation and supply chain initiatives, all of which applies to Corporate and other, and (ii) in 2002 a $7 million charge for severance and write-off of technology investments, all of which applies to Financial Services.
First quarter 2002 amounts have been reclassified to conform to current year classifications. Corrugated Packaging The Company acquired effective control of Gaylord Container Corporation and began consolidating the results of Gaylord in March 2002. The Company also acquired a box plant in Puerto Rico in March 2002, the converting facilities of Mack Packaging Group in May 2002, and Fibre Innovations LLC in November 2002. As a result, the 2003 financial information for Corrugated Packaging is not comparable to prior periods. Corrugated Packaging revenues were $667 million in first quarter 2003 compared with $557 million in first quarter 2002. Revenues from sales of corrugated packaging represented 94 percent of segment revenues in both first quarter 2003 and first quarter 2002. The remaining revenues are derived from sales of linerboard. The change in revenues in 2003 was principally due to the inclusion of the acquired operations, $122 million, partially offset by lower box prices and lower box and linerboard shipments. 21 Average corrugated packaging prices were down two percent. Corrugated packaging shipments, adjusted for the effect of acquisitions in 2002, were down three percent. Average linerboard prices were up two percent. Linerboard shipments, adjusted for the effect of acquisitions in 2002, were down six percent. Compared with fourth quarter 2002, Corrugated Packaging revenues were up $12 million. Average corrugated packaging prices were down less than one percent while shipments were up two percent. Average linerboard prices were down one percent while shipments were down slightly. Corrugated packaging markets continue to be adversely affected by the weak economy. Linerboard markets continue to be adversely affected by both the weak economy and increased offshore capacity partially offset by a weaker U.S. dollar. Costs, which include production, distribution, and administrative costs were $671 million in first quarter 2003 compared with $535 million in first quarter 2002. The change in costs in 2003 was principally due to: - the inclusion of the acquired operations, - higher energy costs, up $22 million, - higher pension costs, up $7 million, and - higher OCC costs, up $3 million. Average OCC cost was $82 per ton during first quarter 2003 compared with $68 per ton during first quarter 2002. OCC prices rose throughout first quarter 2003. It is likely that OCC costs will continue to fluctuate during 2003. Mill production was: - 763,000 tons in first quarter 2003, - 614,000 tons in first quarter 2002, and - 713,000 tons in fourth quarter 2002. Mill production data presented above is not comparable due to the effect of the Gaylord acquisition, beginning on March 1, 2002, and the Antioch shutdown in September 2002. The percentage of mill production used by Corrugated Packaging operations was: - 84 percent in first quarter 2003, - 83 percent in first quarter 2002, and - 83 percent in fourth quarter 2002. The remainder was sold in the domestic and export markets. 22 Excluding routine maintenance, production downtime was: - 46,000 tons in first quarter 2003 due to mix and operational reasons, - 103,000 tons in first quarter 2002 due to market, mix and operational reasons, and - 96,000 tons in fourth quarter 2002 due to market, mix and operational reasons. Production downtime may occur in future quarters. Market conditions continue to be weak for lightweight gypsum facing paper. As a result, the Company's Premier Boxboard joint venture continues to produce corrugating medium. The Company purchased 26,000 tons of corrugating medium from the joint venture in first quarter 2003. It is uncertain when market conditions for lightweight gypsum facing paper will improve. In conjunction with the acquisition of Gaylord, the Company announced its intention to sell several non-strategic assets and operations obtained in the acquisition including the retail bag business, the multi-wall bag business and kraft paper mill, and the chemical business. The only non-strategic asset that remains is the chemical business. The operating results and cash flows of this operation are classified as discontinued operations and are excluded from business segment operating income. The Company expects that it may not sell the chemical business until the toxic tort litigation in which the chemical business is involved is satisfactorily resolved. The Company is continuing its efforts to enhance return on investment within Corrugated Packaging. These efforts include reviewing operations that are unable to meet return objectives and determining appropriate courses of actions including the possible consolidation and rationalization of converting facilities. In March 2003, the Company announced its intention to close permanently its converting facilities in Hattiesburg, Mississippi and Elizabethton, Tennessee, which resulted in an impairment loss of $4 million related to long-lived assets and $2 million in involuntary employee termination liabilities. It is expected that the two box plants will close and severance will be paid during second quarter 2003. These losses and costs are included in other operating expenses and excluded from segment operating income. Corrugated Packaging had a $4 million operating loss in first quarter 2003 compared with income of $22 million in first quarter 2002. 23 Building Products Building Products' revenues were $180 million in first quarter 2003 compared with $190 million in first quarter 2002. The change in revenues in 2003 was principally due to lower average prices and shipments in most product lines as follows: First Quarter 2003 versus First Quarter 2002 Increase (Decrease) in -------------------------------------------- Average Prices Shipments -------------- --------- Lumber (8%) 14% Particleboard (8%) (3%) Gypsum (3%) (7%) MDF -- (4%) Other revenues include sales of high-value timberlands. These sales contributed $1 million in operating income in first quarter 2003 compared with $8 million in first quarter 2002. Compared with fourth quarter 2002, revenues were up $3 million. While average prices for lumber were up four percent, average prices for particleboard were down one percent, gypsum down five percent, and MDF down three percent. Shipments of lumber were up six percent, particleboard up two percent, and MDF up seven percent. Shipments of gypsum were down five percent. Costs, which include production, distribution, and administrative costs were $189 million in first quarter 2003 compared with $180 million in first quarter 2002. The change in costs in 2003 was principally due to: - higher lumber production volumes, up $3 million, - higher energy costs, up $3 million, and - higher pension costs, up $2 million. Production averaged from a low of 66 percent to a high of 76 percent of capacity in the various product lines. Production was curtailed to varying degrees in all product lines in first quarter 2003 to match customer demand. The Company's joint venture operations also experienced production curtailments in first quarter 2003. Production may be curtailed in future quarters to match customer demand. The Company's Del-Tin Fiber LLC MDF joint venture in El Dorado, Arkansas continues to experience production and cost issues, though some improvement was made in first quarter 2003. In January 2003, Deltic Timber Corporation, the partner in this venture, announced its intention to exit this business upon the earliest, reasonable opportunity provided by the market. It is uncertain what effects Deltic Timber's decision will have on the joint venture or its operations. The venture had a net loss of $3 million in first quarter 2003 compared with a net loss of $5 million in first quarter 2002. The Company's share of the venture's loss was $1 million in first quarter 2003 compared with 24 $2 million in first quarter 2002. In first quarter 2003, the Company and Deltic Timber Corporation each contributed $3 million in cash to the venture. The Company is continuing its efforts to enhance return on investment within Building Products. These include reviewing operations that are unable to meet return objectives and determining appropriate courses of action including the possible rationalization of production facilities. In addition, the Company is continuing to address market issues at its particleboard and MDF facilities, including the Del-Tin Fiber MDF joint venture. In April 2003, the Company announced the indefinite shutdown of its Mt. Jewett, Pennsylvania particleboard plant. In connection with this shutdown the Company expects to incur $1 million in involuntary employee termination liabilities. It is expected that these liabilities will be paid during second quarter 2003. Building Products had a $9 million operating loss in first quarter 2003 compared with income of $10 million in first quarter 2002. Financial Services Operations Financial Services' revenues, consisting of interest and non- interest income, were $288 million in first quarter 2003 compared with $273 million in first quarter 2002. Selected financial information for Financial Services follows: Fourth First Quarter Quarter ------------- ------- 2003 2002 2002 ---- ---- ---- (in millions) Net interest income $ 95 $ 92 $ 96 Provision for loan losses (11) (14) (3) Noninterest income 95 85 116 Noninterest expense (140) (129) (153) ----- ----- ----- Segment operating income 39 34 56 Severance and asset write-offs -- (7) -- ----- ----- ----- Operating income $ 39 $ 27 $ 56 ===== ===== ===== Net interest income was $95 million in first quarter 2003 compared with $92 million in first quarter 2002. The change in net interest income in 2003 was principally due to an increase in average earning assets, principally securities, up 16 percent, partially offset by a decline in the net interest spread resulting from the lower interest rate environment combined with the maintenance of an asset sensitive position. If interest rates 25 continue to decline in 2003 it is likely that net interest income will be adversely affected. However, if interest rates begin to rise in 2003, then it is likely that net interest income would be positively affected. The provision for loan losses was $11 million in first quarter 2003 compared with $14 million in first quarter 2002. The provision for first quarter 2003 related principally to commercial and business loans primarily in the asset-based lending and leasing portfolios. The provision for first quarter 2002 related principally to commercial and business loans primarily in the asset-based lending portfolio. Noninterest income includes revenues from mortgage banking and real estate and insurance activities. Noninterest income was $95 million in first quarter 2003 compared with $85 million in first quarter 2002. The change in noninterest income in 2003 was principally due to an increase in mortgage originations. See Mortgage Banking Activities for further information regarding mortgage-banking operations. Noninterest expense was $140 million in first quarter 2003 compared with $129 million in first quarter 2002. The change in noninterest expense in 2003 was principally due to costs associated with the mortgage banking operations, primarily salary, commissions, benefits, and loan servicing and origination expenses. Earning Assets Earning assets include cash equivalents, mortgage loans held for sale, securities, and loans. At first quarter-end 2003, cash equivalents, mortgage loans held for sale, securities, and residential housing loans constituted 77 percent of total earning assets compared with 69 percent at first quarter-end 2002. Securities, which include mortgage-backed and other securities, were $6.0 billion at first quarter-end 2003 compared with $3.8 billion at first quarter-end 2002. The increase in 2003 was due to an effort to increase residential earning assets. Loans were $10.0 billion at first quarter-end 2003 compared with $9.9 billion at first quarter-end 2002 and $9.8 billion at year-end 2002. The following table summarizes the composition of the loan portfolio: 26 First Quarter-End Year-End ----------------- -------- 2003 2002 2002 ------ ------ ------ (in millions) Single-family mortgage $ 2,743 $ 1,961 $ 2,470 Single-family mortgage warehouse 463 392 522 Single-family construction 1,028 1,024 1,004 Multifamily and senior housing 1,892 1,917 1,858 ------ ------ ------ Total residential housing 6,126 5,294 5,854 Commercial real estate 1,765 2,483 1,891 Commercial and business 1,886 1,897 1,856 Consumer and other 191 245 199 ------ ------ ------ 9,968 9,919 9,800 Less allowance for loan losses (122) (136) (132) ------ ------ ------ $ 9,846 $ 9,783 $ 9,668 ====== ====== ====== Single-family mortgages are made to owners to finance the purchase of a home. Single-family mortgage warehouse provides funding to mortgage lenders to support the flow of loans from origination to sale. Single-family construction finances the development and construction of single-family homes, condominiums, and town homes, including the acquisition and development of home lots. Multifamily and senior housing loans are for the development, construction, and lease up of apartment projects and housing for independent, assisted, and memory- impaired residents. Commercial real estate loans provide funding for the development, construction, and lease up principally of office, retail, and industrial projects. Commercial and business loans finance business operations and principally include asset-based, syndicated and middle market loans, and direct financing leases on equipment. Consumer and other loans principally include loans secured by junior liens on single-family homes, not related to their purchase. Although total loans have remained relatively flat over the past year, the composition of the portfolio has changed due to an effort to increase residential housing earning assets. As a result, residential housing loans represent 61 percent of the loan portfolio at first quarter-end 2003 compared with 53 percent at first quarter-end 2002 and 60 percent at year-end 2002. Asset Quality Several key measures are used to evaluate and monitor asset quality. These measures include the level of loan delinquencies, nonperforming loans and assets and net charge-offs compared with average loans. 27 First Quarter-End Year-End ----------------- -------- 2003 2002 2002 ------ ------ ------ (in millions) Accruing loans past due 30 - 89 days $ 95 $ 95 $ 108 Accruing loans past due 90 days or more 15 1 7 ------ ----- ----- Accruing loans past due 30 days or more $ 110 $ 96 $ 115 ====== ===== ===== Nonaccrual loans $ 128 $ 169 $ 126 Restructured loans -- -- -- ------ ----- ----- Nonperforming loans 128 169 126 Foreclosed property 4 3 6 Restructured operating leases 42 -- -- ------ ----- ----- Nonperforming assets $ 174 $ 172 $ 132 ====== ===== ===== Allowance for loan losses $ 122 $ 136 $ 132 Nonperforming loan ratio 1.28% 1.71% 1.28% Nonperforming asset ratio 1.74% 1.74% 1.34% Allowance for loan losses/total loans 1.22% 1.37% 1.34% Allowance for loan losses/nonperforming loans 95.52% 80.31% 104.80% The change at first quarter-end 2003 as compared with first quarter-end 2002 in the level of nonaccrual loans was principally due to payoffs and upgrades of loans in the senior housing portfolio. The change in 2003 in the level of restructured operating leases was due to the restructuring of two leveraged, direct financing leases on cargo aircraft totaling $32 million. Due to a reduction in the lease payments in the restructuring, the leases were reclassified as operating leases. As a result, $20 million in leverage was removed, and the assets were written down to estimated fair market value. The restructured operating leases will be classified as nonperforming until such time as the lessee has evidenced the ability to perform under the terms of the restructured leases. Both the asset-based lending and leasing portfolios, which represent 37 percent of commercial and business loans, will likely continue to be adversely affected by the weak economy. Allowance for Loan Losses The allowance for loan losses is comprised of specific allowances, general allowances, and an unallocated allowance. Management evaluates the allowance for loan losses to ensure the level is adequate to absorb losses inherent in the loan portfolio. The allowance is increased by charges to income and decreased by charge-offs, net of recoveries. 28 Changes in the allowance for loan losses were:
Fourth First Quarter Quarter ------------- ------- 2003 2002 2002 ---- ---- ---- (in millions) Balance at beginning of period $ 132 $ 139 $ 141 Charge-offs: Residential -- -- -- Commercial real estate -- -- -- Commercial and business (21) (18) (12) Consumer and other -- -- -- ----- ----- ----- Total charge-offs (21) (18) (12) Recoveries: Residential -- -- -- Commercial real estate -- -- -- Commercial and business -- 1 -- Consumer and other -- -- -- ----- ----- ----- Total recoveries -- 1 -- ----- ----- ----- Net charge-offs (21) (17) (12) Provision for loan losses 11 14 3 ----- ----- ----- Balance at end of period $ 122 $ 136 $ 132 ===== ===== ===== Net charge-offs (annualized) as a percentage of average loans outstanding 0.86% 0.72% 0.49%
First quarter 2003 charge-offs related principally to two loans in the asset-based lending portfolio and two leveraged direct financing leases, reclassifed as operating leases as of quarter end, on cargo aircraft in the leasing portfolio. The leveraged lease charge-offs totaled $10 million and represented the write down of the underlying assets to their estimated fair market value. First quarter 2002 charge-offs related principally to asset-based loans in the commercial and business portfolio were partially offset by recoveries of $1 million. Mortgage Banking Activities Mortgage loan originations were $3.2 billion in first quarter 2003 compared with $2.0 billion in first quarter 2002. Included in total production were loans originated for the savings bank of $555 million in first quarter 2003 compared with $184 million in first quarter 2002. The significant increase in loans originated for the savings bank in first quarter 2003 was the result of continued efforts to increase the level of single- family mortgage assets at the savings bank. The high level of mortgage loan originations during first quarter 2003 was due to continued refinance activity resulting from the low interest rate environment. Higher interest rates in first quarter 2002 resulted in a significant reduction in mortgage refinancing activity, contributing to the lower level of originations. 29 Mortgage servicing portfolio runoff was 42 percent in first quarter 2003 compared with 26 percent in first quarter 2002. The change in the runoff rate was due to the low interest rate environment in 2003. As a result of the high runoff rates, the mortgage operation recorded significant amortization of mortgage servicing rights and impairment charges in first quarter 2003. Amortization of mortgage servicing rights was $16 million in first quarter 2003 compared with $10 million in first quarter 2002. The provision for impairment of mortgage servicing rights totaled $2 million in first quarter 2003 compared with a reversal of impairment reserves of $2 million in first quarter 2002. The valuation allowance at first quarter-end 2003 was $17 million, compared with $4 million at first quarter-end 2002. In first quarter 2003, the mortgage banking operations sold $2.8 billion in loans to secondary markets by delivering loans to third parties or by delivering loans into mortgage-backed securities that were purchased by third parties. Of the loans sold in first quarter 2003, the only retained interest was mortgage servicing rights of $6 million relating to $600 million of loans. The mortgage servicing portfolio was $10.2 billion at first quarter-end 2003 compared with $11.1 billion at first quarter-end 2002. The change was principally due to significant repayments on loans serviced for third parties and the sale of originated loans on a service released basis. Included in the mortgage servicing portfolio were loans serviced for the savings bank totaling $2.0 billion at first quarter-end 2003 compared with $0.7 billion at first quarter-end 2002. In 2002 and 2003, the mortgage banking operations were significantly affected by the refinancing activity associated with the declining interest rate environment. If interest rates continue to decline in 2003, the level of mortgage originations and the level of mortgage servicing rights impairment will likely remain high. However, if interest rates remain constant or begin to rise in 2003, then the level of mortgage originations and the level of mortgage servicing rights impairment will likely decline. Corporate, Interest and Other Income (Expense) Corporate expenses were $11 million in first quarter 2003 compared with $10 million in first quarter 2002. The change in 2003 was principally due to an increase in pension costs. Parent company interest expense was $35 million in first quarter 2003 compared with $25 million in first quarter 2002. The change is principally due to the full effect of interest expense on debt related to the acquisition of Gaylord. In addition, during second quarter 2002, the parent company effected a number of transactions that lengthened debt maturities and reduced reliance on short-term borrowings. The average interest on 30 borrowings was 7.0 percent in first quarter 2003 compared with 5.3 percent in first quarter 2002. Other operating expenses for first quarter 2003 include $3 million in expenses related to initiatives to consolidate administrative functions and effect improvements in supply chain management. These expenses consist principally of fees paid to third party consultants. The Company expects to incur in 2003 approximately $35 million in relocation, severance, and other expenses related to these initiatives, the majority of which will be incurred and paid during second and third quarter 2003. The Company expects the benefits from these initiatives to begin to be realized in 2004. Pension Expense The Company expects to incur $43 million in non-cash pension expense in 2003, or about $11 million per quarter. Non- cash pension expense in 2002 was $9 million or about $2 million per quarter. The change in 2003 was due to a decrease in the assumed discount rate from 7.50 percent to 6.75 percent, a decrease in the expected rate of return on plan assets from 9.0 percent to 8.5 percent, and an increase in the recognition of the accumulated decline in the fair value of plan assets. Income Taxes The effective tax rate for first quarter 2003 is 42 percent and is based on current expectations of income and expenses for the year 2003. The effective tax rate includes federal and state income taxes and the effects of non-deductible items. In first quarter 2003, the Company amended its tax sharing agreement with its subsidiaries. As a result, Financial Services' effective tax rate now approximates the federal statutory rate as if Financial Services were filing a separate tax return. This amendment has no effect on the Company's consolidated income tax provision or effective tax rate. Average Shares Outstanding Average shares outstanding were 54.0 million in first quarter 2003 compared with 49.5 million in first quarter 2002. The change in 2003 was principally due to the May 2002 sale of 4.1 million shares of common stock. The dilutive effect of stock options and equity purchase contracts was not significant in any of the periods presented. Capital Resources and Liquidity The consolidated net assets invested in Financial Services are subject, in varying degrees, to regulatory rules and regulations including restrictions on the payment of dividends to 31 the parent company. Accordingly, parent company and Financial Services capital resources and liquidity are discussed separately. Parent Company Operating Activities Cash provided by operations was $20 million. The loss for first quarter 2003 included $86 million of depreciation and other non-cash charges. Dividends received from Financial Services were $35 million. Working capital needs increased $47 million, principally due to a $30 million increase in receivables and the payment of year-end 2002 accrued expense. The increase in receivables was due primarily to seasonally higher March revenues. Investing Activities Investing activities used $2 million. Proceeds from the sale of non-strategic assets acquired in connection with the acquisition of Gaylord were $30 million. Capital expenditures were $29 million. Capital expenditures are expected to approximate $170 million in 2003 or about 70 percent of the $240 million of expected depreciation in 2003. Financing Activities Financing activities used $24 million. Cash dividends paid to shareholders were $19 million or $0.34 per share. Debt and other borrowings were reduced $5 million. Liquidity and Off Balance Sheet Financing Arrangements The parent company's sources of short-term funding are its operating cash flows, which include dividends received from Financial Services, and its existing credit arrangements. The parent company operates in cyclical industries, and its operating cash flows vary accordingly. The dividends received from the savings bank are subject to regulatory approval and restrictions. At first quarter-end 2003, the parent company had $666 million in unused borrowing capacity under its existing credit agreements and $148 million under the accounts receivable securitization program. At first quarter-end 2003, the parent company complied with all of the terms and conditions of its credit agreements and accounts receivable securitization program. In 2003, $80 million in credit agreements expire all of which are unused at first quarter-end 2003. The long-term debt of the parent company is currently rated BBB and Baa3 by the rating agencies, with one rating agency maintaining a negative outlook. 32 In first quarter 2003, one of the joint ventures in which the Company participates successfully renewed its letters of credit that were scheduled to expire in second quarter 2003. The Company continues to guarantee one-half, or $28 million of the renewed letters of credit. Financial Services The principal sources of cash for Financial Services are operating cash flows, principal payments on securities, deposits, and borrowings. Financial Services uses these funds to invest in earning assets, generally loans and securities. Operating Activities Cash provided by operations was $260 million. Loans held for sale increased $168 million while escrow cash related to mortgage loans serviced decreased $24 million. Investing Activities Cash used in investing activities was $271 million. Securities purchases, net of maturities, were $25 million and loan originations, net of collections, were $239 million. Financing Activities Cash used for financing activities was $100 million. Borrowings decreased $216 million while deposits increased $150 million. In addition, a $35 million dividend was paid to the parent company. Cash Equivalents Cash equivalents were $327 million at first quarter-end 2003 compared with $438 million at year-end 2002. Other Financial Services' short-term funding needs are met through operating cash flows, attracting new retail deposits, increased borrowings, and converting assets to cash through sales or reverse repurchase agreements. Assets that can be converted to cash include short-term investments, mortgage loans held for sale, and securities. At first quarter-end 2003, Financial Services had available liquidity of $2.2 billion. In addition, at first quarter-end 2003 commitments to originate single-family residential mortgage loans totaled $2.2 billion and commitments to sell single-family residential mortgage loans totaled $1.8 billion. 33 At first quarter-end 2003, the savings bank exceeded all applicable regulatory capital requirements. The parent company expects to maintain the savings bank capital at a level that exceeds the minimum required for designation as "well capitalized." As a result, the Company may make capital contributions to the savings bank. During first quarter 2003, the Company made no capital contributions to the savings bank. Selected financial and regulatory capital data for the savings bank follows: First Quarter Year-End 2003 2002 ----- ------ (dollars in millions) Balance sheet data Total assets $ 17,459 $ 17,479 Total deposits 9,568 9,467 Shareholder's equity 936 944 Savings Regulatory For Categorization Bank Minimum as "Well Capitalized" ------ ---------- ------------------ Regulatory capital ratios: Tangible capital 6.4% 2.0% N/A Leverage capital 6.4% 4.0% 5.0% Tier 1 risk-based capital 9.5% 4.0% 6.0% Total risk-based capital 10.7% 8.0% 10.0% Energy and the Effects of Inflation Energy costs, principally natural gas, were $75 million in first quarter 2003 compared with $50 million in first quarter 2002. Energy costs began to rise during fourth quarter 2002 and continued to rise during first quarter 2003, moderating somewhat in April 2003. It is likely that energy costs will continue to fluctuate during 2003. Litigation and Related Matters On May 14, 1999, Inland Paperboard and Packaging ("Inland") and Gaylord were named as defendants in a Consolidated Class Action Complaint that alleged a civil violation of Section 1 of the Sherman Act. The suit, captioned Winoff Industries, Inc. v. Stone Container Corporation, MDL No. 1261 (E.D. Pa.), names Inland, Gaylord, and eight other linerboard manufacturers as defendants. The complaint alleges that the defendants, during the period from October 1, 1993, through November 30, 1995, conspired to limit the supply of linerboard, and that the purpose and effect of the alleged conspiracy was artificially to increase prices of corrugated containers. The plaintiffs moved to certify a class of all persons in the United States who purchased corrugated containers directly from any defendant during the above period, and seek treble damages and attorneys' fees on 34 behalf of the purported class. The trial court granted plaintiffs' motion on September 4, 2001, but modified the proposed class to exclude those purchasers whose prices were "not tied to the price of linerboard." The United States Court of Appeals for the Third Circuit accepted review of the decision to certify the class and upheld the trial court's ruling. Defendants appealed this decision to the United States Supreme Court, which denied their petition for a writ of certiorari. The case is currently set for trial in April 2004. Inland and Gaylord executed a settlement agreement on April 11, 2003, with the representatives of the class. On April 14, 2003, the trial court entered an order preliminarily approving the terms of the settlement. Inland and Gaylord paid a total of $8 million into escrow on April 17, 2003, to fulfill the terms of the settlement, which amount was within the amount previously accrued by the Company in connection with this matter. Notice of the settlement has been mailed to all members of the classes and will be published in the Wall Street Journal and trade publications. Objections to the settlement, if any, must be filed with the court no later than June 9, 2003. A final hearing on the fairness of the settlement to the classes will be held on August 11, 2003. The settlement will not become final until appeals, if any, to a final order approving the settlement terms have been exhausted. Accounting Policies New Accounting Standards Adopted Stock-Based Compensation Beginning January 2003, the Company voluntarily adopted the prospective transition method of accounting for stock-based compensation contained in SFAS No. 148, Accounting for Stock- Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123. The principal effect of adopting the prospective transition method is that the fair value of stock options granted in 2003 and thereafter are charged to expense over the option vesting period. As a result of the adoption of this prospective transition method, first quarter 2003 net loss was increased by $0.1 million with no effect on earnings per share. Prior to 2003, the Company used the intrinsic value method in accounting for its stock-based compensation. As a result, no stock-based compensation expense related to stock options is reflected in prior years' net income, as all stock options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Therefore, the cost related to stock-based compensation recognized in net income (loss) for first quarter 2003 and 2002 is less than would have been recognized if the fair value method had been applied to all 35 stock options granted since 1995. See Note I for further information regarding stock-based compensation. Asset Retirement Obligations Beginning January 2003, the Company was required to adopt Statement of Financial Accounting Standards (SFAS) No. 143, Accounting for Asset Retirement Obligations. The Statement requires legal obligations associated with the retirement of long- lived assets to be recognized at their fair value at the time that the obligations are incurred. Upon initial recognition of a liability, that cost is capitalized as part of the related long- lived asset and allocated to expense over the useful life of the asset. The effect of adopting this statement was to increase property, plant and equipment by $3 million, recognize an asset retirement obligation liability of $4 million, and to increase first quarter net loss by $1 million or $0.01 per share for the cumulative effect of adoption. Disposal Activities Beginning January 2003, the Company was required to adopt SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Under this statement, liabilities for costs associated with exit or disposal activities, including restructurings, are recognized when the liability is incurred and can be measured at estimated fair value. The effect on earnings or financial position of adopting this statement was not material. Other Pronouncements Also during first quarter 2003, the Company was required to adopt FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others and FASB Interpretation No. 46, Consolidation of Variable Interest Entities. The effect on earnings or financial position of adopting these other pronouncements was not material. Critical Accounting Estimates In first quarter 2003, there were no significant changes in critical accounting estimates from that disclosed in the Company's Form 10-K for the year 2002. 36 Statistical and other data(a) First Quarter 2003 2002 ------ ------ Revenues (dollars in millions) Corrugated Packaging Corrugated packaging $ 625 $ 522 Linerboard 42 35 ----- ----- Total Corrugated Packaging $ 667 $ 557 ===== ===== Building Products Pine lumber $ 56 $ 52 Particleboard 39 43 Medium density fiberboard 26 26 Gypsum wallboard 18 19 Fiberboard 14 16 Other 27 34 ----- ----- Total Building Products $ 180 $ 190 ===== ===== Unit sales Corrugated Packaging Corrugated packaging, thousand tons 780 635 Linerboard, thousands of tons 124 109 ----- ----- Total, thousands of tons 904 744 ===== ===== Building Products Pine lumber, mbf 198 173 Particleboard, msf 155 160 Medium density fiberboard, msf 64 67 Gypsum wallboard, msf 161 173 Fiberboard, msf 87 97 (a) Revenues and unit sales do not include joint venture operations Note: Data for Corrugated Packaging for 2003 is not comparable due to the effect of acquisitions completed in 2002. 37 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk The Company is subject to interest rate risk from the utilization of financial instruments such as adjustable-rate debt and other borrowings, as well as the lending and deposit- gathering activities of Financial Services. In first quarter 2003, there were no significant changes in interest rate risk from that disclosed in the Company's Form 10-K for the year 2002. Additionally, the fair value of mortgage servicing rights (estimated at $102 million at first quarter-end 2003) is also affected by changes in interest rates. The Company estimates that a one percent decline in interest rates from current levels would decrease the fair value of the mortgage servicing rights by approximately $26 million. Foreign Currency Risk In first quarter 2003, there were no significant changes in foreign currency risk from that disclosed in the Company's Form 10-K for the year 2002. Commodity Price Risk In first quarter 2003, there were no significant changes in commodity price risk from that disclosed in the Company's Form 10-K for the year 2002. ITEM 4. CONTROLS AND PROCEDURES (a)Evaluation of disclosure controls and procedures The Company's chief executive officer and its chief financial officer, based on their evaluation of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 13a- 14(c)) as of a date within 90 days prior to the filing of this Quarterly Report on Form 10-Q, have concluded that the Company's disclosure controls and procedures are adequate and effective for the information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission's ("SEC") rules and forms. (b) Changes in internal controls. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. There 38 were no significant deficiencies or material weaknesses revealed through this evaluation and, accordingly, no corrective actions were necessary. PART II. OTHER INFORMATION Item 1. Legal Proceedings. The information set forth in Note E to Notes to Consolidated Financial Statements in Part I of this report is incorporated by reference thereto. On May 14, 1999, Inland Paperboard and Packaging, Inc. ("Inland") and Gaylord were named as defendants in a Consolidated Class Action Complaint that alleged a civil violation of Section 1 of the Sherman Act. The suit, captioned Winoff Industries, Inc. v. Stone Container Corporation, MDL No. 1261 (E.D. Pa.), names Inland, Gaylord, and eight other linerboard manufacturers as defendants. The complaint alleges that the defendants, during the period from October 1, 1993, through November 30, 1995, conspired to limit the supply of linerboard, and that the purpose and effect of the alleged conspiracy was artificially to increase prices of corrugated containers. The plaintiffs moved to certify a class of all persons in the United States who purchased corrugated containers directly from any defendant during the above period, and seek treble damages and attorneys' fees on behalf of the purported class. The trial court granted plaintiffs' motion on September 4, 2001, but modified the proposed class to exclude those purchasers whose prices were "not tied to the price of linerboard." The United States Court of Appeals for the Third Circuit accepted review of the decision to certify the class and upheld the trial court's ruling. Defendants appealed this decision to the United States Supreme Court, which denied their petition for a writ of certiorari. The case is currently set for trial in April 2004. Inland and Gaylord executed a settlement agreement on April 11, 2003, with the representatives of the class. On April 14, 2003, the trial court entered an order preliminarily approving the terms of the settlement. Inland and Gaylord paid a total of $8 million into escrow on April 17, 2003, to fulfill the terms of the settlement, which amount was within the amount previously accrued by the Company in connection with this matter. Notice of the settlement has been mailed to all members of the classes and will be published in the Wall Street Journal and trade publications. Objections to the settlement, if any, must be filed with the court no later than June 9, 2003. A final hearing on the fairness of the settlement to the classes will be held on August 11, 2003. The settlement will not become final until appeals, if any, to a final order approving the settlement terms have been exhausted. 39 On April 3, 2003, the Georgia Department of Natural Resources, Environmental Protection Division sent Inland a Notice of Violation alleging that Inland's linerboard mill in Rome, Georgia, had experienced 502 excess sulfur dioxide emissions in the fourth quarter of 2002 due to the burning of coal with a level of sulfur that was too high. The Company timely filed its response to the State on May 1, 2003. The Company believes the likelihood of a material loss from this to be remote and does not believe that the outcome of this Notice of Violation should have a material adverse effect on its financial position, results of operations, or cash flow. Item 2. Changes in Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. 99.1 - Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 - Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K During the quarter ended March 29, 2003, the Company filed the following Current Reports on Form 8-K: 1. Current Report on Form 8-K dated February 7, 2003, reporting under Item 9 the issuance of the Company's earnings release for the period ended December 29, 2002. 2. Current Report on Form 8-K dated March 26, 2003, reporting under Item 9 a press release issued by the Company commending on earnings for the period ending March 29, 2003. 40 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. TEMPLE-INLAND INC. (Registrant) Dated: May 12, 2003 By: /s/ Louis R. Brill ----------------------- Louis R. Brill Chief Accounting Officer 41 CERTIFICATIONS I, Kenneth M. Jastrow, II, Chief Executive Officer of Temple- Inland Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Temple- Inland Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d- 14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 42 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 12, 2003 /s/ Kenneth M. Jastrow, II ---------------------------- Kenneth M. Jastrow, II Chief Executive Officer 43 CERTIFICATIONS I, Randall D. Levy, Chief Financial Officer of Temple-Inland Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Temple- Inland Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d- 14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 44 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 12, 2003 /s/ Randall D. Levy ------------------------- Randall D. Levy Chief Financial Officer 45 INDEX TO EXHIBITS Exhibit No. Description Page No. ----------- ----------- --------- 99.1 Certification of Chief Executive 46 Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002 99.2 Certification of Chief Financial 47 Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002